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How Blue States Could Cost the Federal Government Billions

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By Michael Rainey

January 25, 2018

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The federal government stands to lose billions of dollars in revenue if high-tax states are successful in finding ways around the new $10,000 cap on state and local tax deductions imposed by the Republican tax overhaul.

Bloomberg News and University of Chicago Law School professor Daniel Hemel calculated that one strategy some states are considering — replacing state income taxes with employer-paid payroll taxes — could reduce federal tax revenues by $154 billion, and that’s just counting the effects from the five high-tax states of California, New York, New Jersey, Connecticut and Illinois.

Nationally, the overall effect could be large enough to wipe out all of the federal revenue generated by the new SALT deduction limit.

The workarounds states are considering would redirect tax revenues from the federal government to state capitals. California would see the biggest effect from the payroll tax plan, with about $66 billion in revenues being redirected from Washington to Sacramento. About $50 billion is at stake in New York, and $16 billion in Illinois.

Frank Sammartin of the Tax Policy Center told Bloomberg that the payroll tax option has “a lot of sticking points, but conceptually it’s a workable scheme,” and experts expect states to test the legal limits of the workaround this year.